SEC says administrative judges not constitutional

The Securities and Exchange Commission was forced to acknowledge its own judicial process is not constitutional after the Justice Department questioned whether the agency’s administrative judges should be considered officers of the United States.

The SEC hastily ratified its five administrative law judges in an order Thursday. In a decision that could have ramifications for many cases, the commission ordered its administrative judges to review all substantive and procedural actions taken in pending proceedings.

The regulatory agency was responding to a petition for a writ of certiorari filed the day before by the new U.S. solicitor general, Noel Francisco. The brief was filed on behalf of the SEC, but it appeared to support the position of the petitioners, who argued administrative judges are not employees but officers of the U.S. who require presidential appointment.

By ratifying its administrative judges, the commission claimed it put to rest “any claim that administrative proceedings … violate the Appointments Clause” of the Constitution.

Defense attorneys said the SEC’s belated ratification does nothing to remedy previous cases.

“The commission’s after-the-fact attempt to cleanse that unconstitutional process in cases that have already been litigated is wrong and must fail,” said David Willingham, a partner with Boies Schiller Flexner LLP who recently finished a trial before an administrative judge that resulted in a partial directed verdict against the SEC.

Other securities attorneys affirmed the SEC’s admission means it might soon be awash in petitions to overturn rulings and settlements. While the appointments issue is clarified for future cases, the SEC did not address constitutional questions around the tenure of its administrative judges.

Given the potential scale of the fallout, securities experts wondered why the commission didn’t ratify its administrative judges from the get-go.

“The fact of the matter is it’s something of a mystery why the SEC didn’t get this right in the first instance,” said Jonathan A. Shapiro, a partner with Baker Botts LLP.

Attorneys speculated the SEC avoided fixing this problem because of the retroactivity issue. But stalling allowed the appointments clause question to plague the appellate courts for years.

The U.S. Court of Appeals for the D.C. Circuit held that the SEC’s administrative judges are employees, not officers. But a divided en banc panel denied the petition for review, which vacated the panel’s judgment.

Addressing a similar question, the 10th U.S. Circuit Court of Appeal disagreed with the D.C. Circuit. In re: David F. Bandimere, Securities Act Release No. 9972, 2015 WL 6575665 (Oct. 29, 2015).

The Supreme Court’s treatment of this question will have widespread implications for other federal agencies that use administrative judges, including the Consumer Financial Protection Bureau, the Federal Energy Regulatory Commission, the National Labor Relations Board, and the Environmental Protection Agency, according to the solicitor general.

“It’s not just an SEC question: it’s a broader question,” Shapiro said. He added that the Supreme Court’s focus would be narrowed to resolving the deadlock between the D.C. Circuit and the 10th Circuit, but it would inform similar doctrinal questions in other administrative law cases.

The high court touched on this issue earlier this week in a case where petitioners challenged the constitutionality of the inter partes review process used by the U.S. Patent Trial & Appeal Board. Patent litigators said there is a similar issue, which is whether patents invalidated under inter partes review would be considered invalid if the court determines the process is unconstitutional.

Another thorny question is how Chief Justice John G. Roberts will address the issue of non-Article III judges. In 2011, he wrote a decision that found Congress acted inappropriately by giving federal bankruptcy judges the right to decide issues of state law. Like administrative judges, bankruptcy judges are not presidentially appointed.

Despite uncertainty about how the Supreme Court will address the issue of administrative judges, attorneys said they doubted they will be abolished altogether.

“I don’t see that as a realistic scenario,” said Mark Mermelstein, a partner with Orrick, Herrington & Sutcliffe LLP. He suggested it would be absurd to ask federal judges to handle all these cases, given they’re already overburdened.

“It seems to me there is a workaround here, which is to approve to the ALJs in a procedurally proper way,” Mermelstein said.

This is the more significant issue for securities attorneys, who have long-standing complaints about what they see as the inherent unfairness of the SEC’s in-house administrative proceedings. Among the most common critiques is the absence of a jury, limited discovery, and the ample time given to the SEC to pursue its pre-litigation investigations.

“The playing field is so un-level you can see the slope from space,” Shapiro quipped, adding that none of these issues have to do with the appointment clause.

“Let’s assume the appointment clause is finally resolved. The ALJ process that emerges is not going to be fundamentally any more fair than when it started,” Shapiro said.

An SEC official did not immediately respond to a request for comment.